Time out - The cause of the next big market setback will not be the time passed since the last one
Towards the end of January, analysts at Societe Generale issued a research piece observing how some market watchers were growing increasingly nervous that the number of days since the MSCI world index last suffered a 10%-or-more correction had now passed the 400 mark – the eighth longest period on record.
While conceding “simply not having a correction for a long time does not necessarily imply impending doom for equities”, the Socgen analysts still worried that “in these times of interconnected asset markets and mark-to-market risk modelling, such extended runs can hide the real volatility in equity investing”. “In brief,” they concluded, “it can lead to excessive risk taking.”
Here on The Value Perspective, we acknowledge the way investors can instinctively focus on issues of time when they are looking for interesting market trends. Thus, for example, we are constantly seeing new research on the average duration of recoveries or rallies or setbacks, the likely direction of markets in a particular month or presidential cycle and so on and so forth.
However, we also know investors need to be careful about going on instinct and where we struggle with concerns that a market has not corrected in so-many-hundred days is that consistency does not necessarily indicate causality. Investors should always look to get to the bottom of a market pattern and, yes, often there will be a good reason for it occurring and often it will relate to human nature.
But what you cannot lose sight of with a time-based cycle or trend is there will never be any foundation for believing that, just because something has or has not been happening for a prolonged period of time, some sort of change is inevitably around the corner. That is classic ‘gambler’s fallacy’ – you may have flipped three heads in a row but it does not follow that a tail must come up next.
It may be one of the hardest aspects of probability to get your head around but, even if you manage to flip heads 50 times in a row, the odds of you flipping tails next time are still 50/50. That said, it may well be that the fact the market has not had a 10%-plus setback in over a year is actually laying the causal foundation for the next such correction – by virtue of the market growing ever more expensive.
One thing we do know for sure – and we are aware we may have mentioned this once or twice before on The Value Perspective – is the market’s valuation dictates whether or not you are likely to have a setback because, in the end and over time, the market’s valuation is the defining factor of whether or not it goes up or down. As such, absolute valuation should be the focus of an investor.
Interestingly, what the 400-days-and counting observation does offer some insight into is that investors appear a good deal more relaxed today than they have been for quite some time. And of course, the longer the market avoids a correction, the more relaxed investors will become and the more the conditions for a potential setback will be reinforced. But it is behavioural factors such as these, which are going on as time passes, that will cause the next big market setback rather than time itself.
Fund Manager, Equity Value
I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
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